Evaluating potential going concern issues was a hot topic for companies and their auditors for 2020 year-end reporting. As many chief financial officers and accounting executives are preparing for first-quarter 2021 reporting, they find the business disruptions and uncertainties from the COVID-19 pandemic and its economic impacts are still with them and continue to pose reporting challenges.
Accounting and auditing standards for going concern require management and auditors to share the responsibility for analyzing and reporting whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date the financial statements are issued or available to be issued. Management must perform this evaluation at every interim and annual reporting date. This exercise is no longer as simple and routine as in the past, requiring more than a review of budgets and short-term financial commitments. Assumptions must be made about the timing and extent of any expected turnaround in the economy and effects on the company.
Historically, CFOs and audit committees did not want to find themselves in the position of having to disclose going concern doubts in their financial statements or audit reports because of the negative outlook it could send to investors, customers, suppliers, and lenders. But these disclosures are now much more common than in the recent past.
Audit opinions of public companies that included going concern uncertainties are projected to reach a 20-year low in fiscal year 2019, based on the latest report from Audit Analytics. The study attributes this decrease to companies dropping out of the population being analyzed rather than to improved financial results. Meanwhile, audit opinions disclosing going concern uncertainties for the first time in 2019 (new going concerns) were expected to increase for the first time since 2014, with company operating losses being the most common reason disclosed. The report also estimates an increase in the percentage of audit opinions expressing going concern uncertainties to 15.2 percent, the first rise after 10 consecutive years of decline.
These results are not surprising and reflect both the current environment and increased attention to this topic by auditors and regulators. “Evaluating a company’s ability to continue as a going concern is part of complying with GAAP, and if a company concludes substantial doubt about its ability to continue as a going concern exists it doesn’t get to choose whether to disclose it,” said Steve Barta, Deloitte partner and coauthor of a recent publication about COVID-19 and going concern risk. “But CFOs do have a choice about how they handle the run-up and execution of that disclosure.”
Here are some key going concern considerations to be thinking about now and over the next 12 months:
Identify what is known and knowable. Management must assess the gross risks relating to the conditions and events that create doubt about going concern. The pandemic’s future impacts are not knowable, and economic uncertainties can change week to week. Companies should focus on their ability to meet their obligations as they come due based on their most current business information and financial projections. There may be a need to revise cash flow and profit and loss forecasts, or create multiple scenarios, if existing budgets and forecasts do not reflect recent changes in the economy and business operations. Companies should also assess their current ability to access capital markets and remain liquid despite short-term cash flow issues.
Consider a range of mitigation plans. Management must also assess the net risks after considering any operational or financial mitigating plans that can alleviate going concern doubts. GAAP specifies plans can only be considered if they are probable of being implemented and mitigating the conditions and events that raise doubt. The outcome of the evaluation determines the required going concern disclosures.
There may be specific known issues, like potential debt covenant violations and the ability to renegotiate existing agreements, that have identifiable plans. But the broad economic issues from the pandemic may require companies to identify additional hypothetical situations and develop and document a range of mitigation plans for potential areas of doubt about the ability to continue as a going concern with probabilities under different market conditions. Examples include selling underutilized assets, changing lease versus buy strategies, cutting or delaying costs, or divesting parts of the business.
Evaluate internal controls. To comply with going concern requirements, internal controls and processes must be in place to identify current and future company-specific issues, along with industry issues and global economic impacts. Data used for assumptions and forecasts must be accurate and up to date, which is challenging in a changing environment, and the evaluation process needs to be consistently applied and well documented. Changes in personnel and working remotely can impact internal controls that were in place before the pandemic.
Communicate with key stakeholders early and often. Involve the audit committee, board of directors, and others within the organization who can collaborate to have productive conversations about going concern doubts for the next year and the impacts of COVID-19 on operations. Everyone should understand the accounting and disclosure requirements and consequences of noncompliance. Management can then perform a detailed risk assessment across the organization, plan for various business scenarios, and make more informed decisions about whether disclosure of going concern uncertainty is required.
Update going concern disclosures. Disclosures must be provided in the notes to financial statements, in both annual and interim periods, of management’s plans and whether substantial doubt is or is not alleviated by the plans. These disclosures must be included until the conditions or events giving rise to the uncertainties are resolved. Since going concern risks and plans are continuing to evolve because of the ongoing impacts of COVID-19, the disclosures should be evaluated each period and changed as needed to provide the most updated information.